Jim O’Neil, head of global economic research at Goldman Sachs, writes on China and the yuan in Thursday’s Telegraph:
I’ve concluded that Mr Zhou is telling us that China is closer than many think to letting the yuan become part of the SDR. To do that, he needs to allow greater commerciality of the Chinese currency, i.e. let people use it inside and outside China. He knows that, without that, it couldn’t become part of the SDR. I suggest he questions, just as I do, whether anyone will want to use it unless the SDR becomes something different.
“Becomes something different”? Whatever does he mean?
Well, we presume he means when the SDR becomes something more than a potential claim on the freely usable currencies of IMF members – e.g. more of a reserve currency, or perhaps forms the basis for a system of exchange-rate co-ordination.
Writing in the FT earlier this month Wang Qishan, vice premier of the state council of China suggested as much when he said (emphasis ours):
Concerning financial stability, we should keep exchange rates of major currencies stable through exchange rate policy co-ordination. …….
In terms of reforming the international financial system, with the goal of shaping a new international financial order that is fair, just, inclusive and orderly, we should together call for and promote balanced diversification in the international monetary system to ensure and support its stability. We should advance reform of international financial institutions such as the International Monetary Fund, the World Bank and the Financial Stability Board so as to increase the representation and voices of developing countries and make sure that the decision-making process is transparent, fair and just.
(H/T to Samir Patel at BH2)
But if the yuan were to become a serious contender for SDR inclusion, what would that actually mean for global currencies? Remember, the SDR is made up of the combined value of basket of currencies including sterling, the dollar, the euro and the yen.
A shift to an SDR reserve system, without inclusion of the yuan, would simply mean a reallocation of reserves away from the dollar and towards sterling, the yen and the euro.
Accordingly, as analysts at the research unit of BH2 – a Central London real-estate advisory firm – wrote on May 1st, this is ultimately bullish for the other constituent SDR currencies:
Remaining with global issues it is worth remembering the world has not run out of money, it’s just not where it used to be. The nations (from giants like China, to what are no more than city states like Abu Dhabi) that hold savings will pinpoint the UK and sterling assets as a destination into which to move chunks of this largely dollar denominated pool of wealth.
With anything between three to six trillion dollars 3 set to rotate over coming quarters into other currencies – gold included as a ‘currency’ — Sovereign debt yields will compress from the UK to Russia, as respective currencies strengthen. Repeating what we have long maintained, the UK will rebound before all other European economies bar, say, Norway. As a result the UK will prove a honey-pot for capital and labour escaping the Continent, with the former exploiting an over-sold pound.
Which, according to BH2, would also be good for the UK’s prime commercial real estate market:
Arriving capital will seek-out secured yield, and will no doubt give the UK’s prime commercial real estate market its long over due investment boost (albeit with marked variances across property types). Similarly, the arrival of a new wave of economic migrants will boost the UK residential rental market and lift private consumption. True, new arrivals will brush by those trying to escape higher taxes. However, entrants will number hundreds of thousands, whilst figures for evacuees will be far smaller. After all, disgruntled high earners will be challenged finding destinations in need of their services which are not also raising taxes. Indeed, those heading for jobs in the Gulf or Shanghai will find themselves passing capital winging its way to the City of London, as well as locals grateful to be seconded there to work in their firm’s newly opened offices.
Meanwhile, if the yuan does muscle its way into the SDR grouping, the team sees the following transpiring:
Beijing has managed China’s economy in textbook fashion for the last eight years and is not going to mess up now. For greater convertibility read more freedom for the yuan to find its own level. Left to its own devices the yuan would strengthen against the dollar – as it was doing from mid 2005 through to the early autumn of last year until the lid was put back on by Beijing. To become part of the SDR one of that baskets existing constituents will have to make room.
Which will it be? The loser will be the dollar, a currency whose exclusivity in global commodity pricing is almost up. Fear for Treasury prices when the whistle blows on the dollar. Finally, Beijing should not fear a strengthening in the yuan; as it strengthens it will allow the authorities to loosen monetary policy still further. Too many economies have kept their currencies artificially weak for too long and in having done so have held back the development of their own internal economies.”
In short, Beijing has much less of a reason to fear yuan appreciation now than it did before. That’s because on account of the financial crisis China is being forced to reassess its economic dependence on cheap exports, in favour of stimulating domestic demand.
As Vitaliy Katsenelson at the Contrarian Edge notes here:
How can China, a mainly export economy, continue to thrive when its exports are falling? The answer is that today’s China is a story of two competing economies: the real economy, producing goods and services for mostly external consumption, which is declining at a tremendous rate and the government-spending stimulated economy, which is currently expanding on steroids.
If that’s true, it could mean China has, for the time being at least, realised that trying to resuscitate exports is a redundant exercise.
Accordingly, the old model of co-dependence between China and the US – where China keeps its currency low to remain price competitive in the West – no longer works for either country.
As Paul Krugman wrote earlier last week, this is largely down to the liquidity trap facing China, which in turn means China’s diversification away from the dollar is actually good for everyone – including the US:
Or to put it a third way, the argument that a reduction in China’s dollar purchases would be contractionary for America because it would drive up interest rates is equivalent to the argument that fiscal expansion is contractionary for the same reason — and equivalently wrong. But what if China doesn’t spend more, but just reallocates its reserves from dollars to, say, euros? The answer is, that’s also good for us: a weaker dollar will help our exports, at Europe’s expense. One of the things I tried to tell the Chinese was precisely that the old co-dependence no longer exists. For now, at least, their dollar purchases are an unalloyed bad thing from America’s point of view.
As we noted earlier this week, US Treasury Tim Geithner is off to China on May 30th. It will be interesting to see what rhetoric emerges considering the above and also in light of his latest comments on Thursday:
16:04 21May09 RTRS-US’S GEITHNER SAYS MUST PUT IN PLACE POLICIES THAT SUSTAIN CONFIDENCE IN DOLLAR
As Marc Ostwald at Monument Securities suggested in an emailed note, this sort of implies Geithner believes the US currently does not have the appropriate policies in place:
Is this another tactical error from Timmy Geithner. I believe the Rubin, Summers, Uncle Tom Cobbley & all other Treasury Secretaries’ since way of phrasing of this has always been ‘we have a strong dollar policy’.
Related links:
Chop, chop, chop the dollar – FT Alphaville
Roubini: the renminbi will replace the dollar – FT Alphaville
A paper-gold reserve system? - FT Alphaville
Geithner not wrong, simply misunderstood – FT Alphaville
China and the liquidity trap - Paul Krugman